How Long Can Bond Yields Stay Low?

Despite numerous predictions that bond yields would soar (and therefore bond prices would fall), yields have actually fallen so far in 2014. After rising from record lows last year, the yield on 10-year US treasury bonds is currently around 2.5%, still far below its typical historical range. How long can bond yields stay so low? The answer is “possibly a very long time” based on the experiences of other countries.

The country that has the most experience with low bond yields is Japan. Following its real estate and stock market collapses a quarter century ago, interest rates started declining, with the yield on 10-year Japanese treasury bonds falling below 2% in the late 1990’s. It’s stayed below 2% almost constantly ever since, as weak economic growth and a low (even sometimes negative) inflation rate have given investors little reason to ditch the perceived safety of the country’s government bonds.

It’s unlikely that the US will experience such a lengthy period of such low yields. There are a few key factors working in favor of stronger economic growth for the US economy, such as more favorable demographic trends and an inflation rate that has mostly stayed in positive territory. In theory US policymakers should also be able to learn from Japan’s long stagnation to help avoid a similar fate.

Still, there’s no rule of economics that says that interest rates have to revert toward their average historical levels. The lesson from Japan’s experience should be that if economic growth remains weak and the inflation rate remains subdued (and there are plenty of economists who have this outlook), bond yields could remain low for a very long time.